The Gig Economy (sic)

The Gig Economy has merely exposed the lie that our labor is the most valuable asset we own. Rather, our man-hours have been depreciated drastically in the last 50 years. Much of this has been due to the explosion in capital credit after the abandonment by Nixon in 1971 of the gold peg under the Bretton Woods international monetary regime. This has led to capital-labor substitution, technological innovation, and productivity increases that have reduced the demand for labor, both skilled and unskilled. It’s made some of us richer.

The second contributing factor has been capital mobility under globalization and the liberalization of the populations of the developing world. This has led to a vast increase in the supply of both skilled and unskilled labor. China and India, for the past 30 years, but we still have Africa and South America in the pipeline. 

The combined effect of these policies and geopolitical trends has driven the marginal price of labor down towards the subsistence level. We need to think outside this shrinking box. Btw, union organization will do nothing to reverse these trends unless the focus is not on controlling the supply of labor and artificially raising wages. Asset ownership, risk sharing, and personal data ownership are key.

(Note: We can’t really expect Vanity Fair to tackle these issues.)

“What Have We Done?”: Silicon Valley Engineers Fear They’ve Created a Monster

Vanity Fair

In the heart of San Francisco, the gig economy reigns supreme. Walk into a grocery store, and a large number of shoppers you see are independent contractors for grocery-delivery start-up Instacart. Step outside, and cars with black-and-white Uber stickers or flashing Lyft dashboard lights are sitting, hazards on, blocking the bike lane as they wait for passengers. Cyclists zigzag around the cars, many hauling bags branded with various logos—Caviar, Postmates, Uber Eats—as they deliver food to customers around the city. You can stand on a street corner and count the number of gig-economy workers walking by, as I often do; sometimes it’s 2 out of every 10. On some corners, like the one near the Whole Foods on 4th and Harrison, I’ve counted 8 out of every 10.

The gig-economy ecosystem was supposed to represent the promised land, striking a harmonious egalitarian balance between supply and demand: consumers could off-load the drudgery of commuting or grocery shopping, while workers were set free from the Man. “Set your own schedule,” touts the Uber-driver Web site; “Be your own boss,” tempts Lyft; “Make an impact on people’s lives,” lures Instacart. These companies have been wildly successful: Uber, perhaps the most notorious, is also the most valuable start-up in the U.S., reportedly worth $72 billion. Lyft is valued at $11 billion, and grocery delivery start-up Instacart is valued at just over $4 billion. In recent months, however, a spate of lawsuits has highlighted an alarming by-product of the gig economy—a class of workers who aren’t protected by labor laws, or eligible for benefits provided to the rest of the nation’s workforce—evident even to those outside the bubble of Silicon Valley. A July report commissioned by the New York City Taxi and Limousine Commission found that 85 percent of New York City’s Uber, Lyft, Juno, and Via drivers earn less than $17.22 an hour. When the California Supreme Court ruled in May that delivery company Dynamex must treat its gig workers like full-time employees, Eve Wagner, an attorney who specializes in employment litigation, predicted to Wired, “The number of employment lawsuits is going to explode.”

Of course, the threads of this disillusionment are woven into the very structure that has made these start-ups so successful. A few weeks into my tenure at Uber, where I started as a software developer just a year after graduating from college, still blindly convinced I could make the world a better place, a co-worker sat down next to my desk. “There’s something you need to know,” she said in a low voice, “and I don’t want you to forget it. When you’re writing code, you need to think of the drivers. Never forget that these are real people who have no benefits, who have to live in this city, who depend on us to write responsible code. Remember that.”

I didn’t understand what she meant until several weeks later, when I overheard two other engineers in the cafeteria discussing driver bonuses—specifically, ways to manipulate bonuses so that drivers could be “tricked” into working longer hours. Laughing, they compared the drivers to animals: “You need to dangle the carrot right in front of their face.” Shortly thereafter, a wave of price cuts hit drivers in the Bay Area. When I talked to the drivers, they described how Uber kept fares in a perfectly engineered sweet spot: just high enough for them to justify driving, but just low enough that not much more than their gas and maintenance expenses were covered.

Those of us on the front lines of the gig economy were the first to spot and expose its flaws—two months after leaving Uber, I wrote a highly publicized account of my time there, describing the company’s toxic work environment in detail. Now, as Silicon Valley struggles to come to terms with its corrosive underpinnings, a new vein of disquiet has wormed its way into the Slack chats and happy-hour outings of low-level rank-and-file engineers, spurred by a question that seems to drown out everything else: What have we done? It’s a question that I, too, have been forced to grapple with as I notice how my job as a software engineer has changed the nature of work in general—and not necessarily for the better.

The risk, we agreed, is that the gig economy will become the only economy.

Gig-economy “platforms,” as they’re called, take their inspiration from software engineering, where the goal is to create modular, scalable software applications. To do this, engineers build small pieces of code that run concurrently, dividing a task into ever smaller pieces to conquer it more efficiently. Start-ups function in a similar way; tasks that used to make up a single job are broken down into the smallest possible code pieces, then partitioned so those pieces can be accomplished in parallel. It’s been a successful approach for start-ups for the same reason it’s a successful approach to writing code: it is perfectly, beautifully efficient. Across so-called platforms, there are no individuals—no bosses delegating tasks. Instead, various algorithms run on the platform, matching consumers with workers, riders with the nearest driver, and hungry customers with delivery people, telling them where to go, what to do, and how to do it. Constant needs and their quick solutions all hummingly, perpetually aligned.

By now it’s clear that these companies represent more than a trend. Though it’s difficult to accurately determine the size of the gig economy—estimates range from 0.7 to 34 percent of the national workforce—the number grows with each new start-up that figures out how to break down another basic task. There’s a relatively low risk associated with launching gig-economy companies, start-ups that can engage in “a kind of contract arbitrage” because they “aren’t bearing the corporate or societal cost, even as they reap fractional or full-time value from workers,” explains Seattle-based tech journalist Glenn Fleishman. Thanks to this buffer, they’re almost guaranteed to multiply. As the gig economy grows, so too does the danger that engineers, in attempting to build the most efficient systems, will chop and dice jobs into pieces so dehumanized that our legal system will no longer recognize them. [Note: yes, labor contracts will be obsolete and meaningless, which means asset ownership is the only defensible right.] And along with this comes an even more sinister possibility: jobs that would and should be recognizable—especially supervisory and management positions—will disappear altogether. If a software engineer can write a set of programs that breaks a job into smaller increments, and can follow it up with an algorithm that fills in as the supervisor, then the position itself can be programmed to redundancy.

A few months ago, a lunchtime conversation with several friends turned to the subject of the gig economy. We began to enumerate the potential causes of worker isplacement—things like artificial intelligence and robots, which are fast becoming a reality, expanding the purview of companies such as Google and Amazon. “The displacement is happening right under our noses,” said a woman sitting next to me, another former engineer. “Not in the future—it’s happening now.

“What can we do about it?” someone asked. Another woman replied that the only way forward was for gig-economy workers to unionize, and the table broke out into serious debate [Labor contracts, union or otherwise, will be legally ill-defined and indefensible]. Yet even as we roundly condemned the tech world’s treatment of a vulnerable new class of worker, we knew the stakes were much higher: high enough to alter the future of work itself, to the detriment of all but a select few. “Most people,” I said, interrupting the hubbub, “don’t even see the problem unless they’re on the inside.” Everyone nodded. The risk, we agreed, is that the gig economy will become the only economy, swallowing up entire groups of employees who hold full-time jobs, and that it will, eventually, displace us all. The bigger risk, however, is that the only people who understand the looming threat are the ones enabling it. 

QE Pains and Gains

Reprinted from Bloomberg.

The Unintended Consequences of Quantitative Easing

Asset inflation doesn’t have to be bad. Flush governments could invest in education and infrastructure.
August 21, 2017, 11:00 PM PDT

Quantitative easing, which saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion, has boosted asset prices across the board. That was the aim: to counter a severe economic downturn and to save a financial system close to the brink. Little thought, however, was put into the longer-term consequences of these actions.

From 2008 to 2015, the nominal value of the global stock of investable assets has increased by about 40 percent, to over $500 trillion from over $350 trillion. Yet the real assets behind these numbers changed little, reflecting, in effect, the asset-inflationary nature of quantitative easing. The effects of asset inflation are as profound as those of the better-known consumer inflation.

Consumer price inflation erodes savings and the value of fixed earnings as prices rise. Aside from the pain consumers feel, the economy’s pricing signals get mixed up. Companies may unknowingly sell at a loss, while workers repeatedly have to ask for wage increases just to keep up with prices. The true losers though are people with savings, which see their value in real purchasing power severely diminished.

John Maynard Keynes famously said that inflation is a way for governments to “confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Critically, inflation creates much social tension: “While the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at the confidence in the equity of the existing distribution of wealth.”

Asset inflation, it turns out, is remarkably similar. First, it impedes creative destruction by setting a negative long-term real interest rate. This allows companies that no longer generate enough income to pay a positive return on capital to continue as usual rather than being restructured. Thus the much-noted growth of zombie companies is one consequence of asset price inflation. Thus also the unreasonable leverage and price observed in real estate, with the credit risks it entails for the future.

Second, it also generates artificial winners and losers. The losers are most found among the aging middle class, who, in order to maintain future consumption levels, will now have to increase their savings. Indeed, the savings made by working people on stagnant wages effectively generates less future income because investable assets are now more expensive. The older the demographics, the more pronounced this effect. Germany, for instance, had a contraction of nearly 4 percent of gross domestic product in consumer spending from 2009 to 2016.

The winners are the wealthy, people with savings at the beginning of the process, who saw the nominal value of their assets skyrocket. But, as with consumer inflation, the biggest winner is the state, which now owns through its monetary authority, a large part of its own debt, effectively paying interest to itself, and a much lower one at that. For when all is accounted for, asset inflation is a monetary tax.

The most striking similarity between consumer price inflation and asset inflation is its potential to cause social disruption. In the 1970s workers resorted to industrial action to bargain for wage increases in line with price increases.

Today, the weakened middle class, whose wages have declined for decades, is increasingly angry at society’s wealthiest members. It perceives much of their recent wealth to be ill-gotten, not resulting from true economic wealth creation [and they are correct], and seeks social justice through populist movements outside of the traditional left-right debate. The QE monetary disruption almost certainly contributed to the protest votes that have been observed in the Western world.

The central banks now bear a large responsibility. If they ignore the political impact of the measures they took, they will exacerbate a politically volatile situation. If, on the other hand, the gains made by the state from QE can be channeled to true economic wealth creation and redistribution, they will have saved the day.

This is entirely possible. Rather than debating how and how fast to end quantitative easing, the central bank assets generated by this program should be put into a huge fund for education and infrastructure. The interest earned on these assets could finance real public investment, like research, education and retraining. [That’s fine, but it does little to compensate for the massive transfer of existing wealth that is causing the political and social dislocations, such as unsustainable urban housing costs.]

If the proceeds of QE are invested in growth-expanding policies, the gain will help finance tomorrow’s retirements, and the government-induced asset inflation can be an investment, not simply a tax.

UBI, or Something Better?

What’s odd about this discussion on Universal Basic Income below is that nobody successful in Silicon Valley participates in a UBI scheme, nor would they. They rely on risk-taking, equity, and reward. Not sure why they don’t advocate this for everybody – after all, because of the way risk is assigned to asset ownership, labor ends up taking all kinds of risk, yet almost never participates in the rewards to that risk. Instead they get a one-time bonus or profit-sharing.

But Zuckerberg would never accept those terms, either now or before he made his first dollar. It looks to me that Silicon valley tech supports redistribution in order to make their outsized gains from network effects more politically palatable.

Unfortunately, this critic of Zuckerberg and Silicon Valley in general wants to double down on failed tax and redistribution schemes instead of empowering people to participate in the risks and rewards of capitalist entrepreneurial success.

“He (or She) who is without capital in a capitalist society is little more than a wage slave and a captive consumer.” 

Another truism about the future: In a world run by robots, he who owns and controls the robots is king. Make sure you own your robot!

Original article here.

What Mark Zuckerberg Gets Wrong About UBI

New Republic, July 7, 2017

By Clio Chang

It’s no secret that tech bros love universal basic income. Sam Altman of Y Combinator is funding a UBI pilot program in Oakland, California, in part because he was inspired by Star Trek. Tesla’s Elon Musk supports the policy because he realizes that the aggressive automation caused by the tech industry will make UBI “necessary.” This week, as part of his “I’m-not-running-for-president” tour around the country, Mark Zuckerberg visited Homer, Alaska, which resulted in him writing a Facebook post lauding the merits of the state’s Permanent Fund as a model for a national form of basic income.

UBI, a concept that dates back centuries, is the idea that every person should receive some amount of money so that no one dips beneath a basic standard of living. For those on the left, it’s seen as an alternative to our country’s woefully limited cash welfare system. For libertarians, a basic income is lauded as a slimmer, less intrusive way to deliver government benefits. It is the rare utopian idea that people of different political stripes can agree on—Zuckerberg himself made sure to note the “bipartisan” appeal of the policy in his post.

But Zuckerberg reveals exactly why the left should be alarmed that Silicon Valley is taking the lead on this issue.

First, the idea that UBI has bipartisan appeal is disingenuous. The left would have a policy that redistributes wealth by funding UBI through a more progressive tax scheme or the diverting of capital income. But libertarians like Charles Murray argue for a UBI that completely scraps our existing welfare state, including programs like Medicare, Medicaid, and housing subsidies. This would be extremely regressive, since money currently directed towards the poor would instead be spread out for a basic income for all. And certain benefits like health insurance can’t effectively be replaced with cash.

Second, Zuckerberg asserts that Alaska’s Permanent Fund—which uses the state’s oil resources to pay a dividend to each Alaskan and is seen as one of the few examples of an actual UBI-like policy—is advantageous because it “comes from conservative principles of smaller government, rather than progressive principles of a larger safety net.” But a UBI policy can only reflect small government principles if one envisions it eating into the country’s existing welfare state, rather than coming on top of it. In this respect, Zuckerberg’s advocacy of UBI “bipartisanship” starts to look more like a veiled libertarian agenda.

This attitude echoes other pro-UBI tech lords like Altman, who sees basic income as providing a “floor” but not a ceiling. In his ideal scheme, no one will be very poor, but people like Altman will still be free to get “as rich as they fucking want.” The tech vision of the world is one where it can wash its hands of the rising joblessness it will generate through automation, but where those at the top can still wallow in extreme wealth. As Altman told Business Insider, “We need to be ready for a world with trillionaires in it, and that’s always going to feel deeply unfair. It feels unfair to me. But to drive society forward, you’ve got to let that happen.”

This is deeply telling of the tech UBI mentality: driving society forward doesn’t mean reducing inequality, but rather fostering more entrepreneurship. The former is viewed as unnecessary and the latter as an inherent good.

Zuckerberg also compares Alaska’s Permanent Fund to running a business—a very specific one:

Seeing how Alaska put this dividend in place reminded me of a lesson I learned early at Facebook: organizations think profoundly differently when they’re profitable than when they’re in debt. When you’re losing money, your mentality is largely about survival. But when you’re profitable, you’re confident about your future and you look for opportunities to invest and grow further. Alaska’s economy has historically created this winning mentality, which has led to this basic income. That may be a lesson for the rest of the country as well.

The idea that a “winning mentality” is what is going to lead to a basic income in the United States reveals how little Zuckerberg understands about politics. This is a pervasive ideology among tech leaders, who believe the lessons that they have gleaned from their own industry are applicable to all of the country’s problems. But remember the last time a disrupter said he was going to step into the political arena and run our country like a business?

For moguls like Zuckerberg, there is never any deep consideration of, say, the fact that racism, sexism, and classism are deeply intertwined with our country’s policies and are some of the biggest obstacles to implementing a highly redistributive policy like a UBI. Nor is there any attempt to consult with lifelong organizers and activists on the issue.

At the end of his post, Zuckerberg states that the “most effective safety net programs create an incentive or need to work rather than just giving a handout.” This echoes the “personal responsibility” rhetoric that drove workfare policies in the 1990s, which ended up kicking millions of people off of welfare rolls, leaving them in extreme poverty. The line also directly undermines the push for a UBI, which is quite literally a handout that can help liberate people from the “need to work.”

It would appear that Silicon Valley’s support for a basic income comes from self-interest. As Jathan Sadowski writes in the Guardian, “the trouble comes when UBI is used as a way of merely making techno-capitalism more tolerable for people, when it is administered like a painkiller that numbs the pain and masks the symptoms of economic injustice without addressing the root causes of exploitation and inequality.”

Tech moguls may seem like tempting allies for UBI advocates, but their vision of an ideal social safety net does not look anything like the left’s. If it did, they wouldn’t be pushing just for a basic income, but also for things like universal health care, free public education (not just for engineers!), and strong labor unions. For Silicon Valley, UBI is a sleek technological means to a very different end.

Statistical Fixations

Martin Feldstein is nowhere near as excitable as David Stockman on Fed manipulations (link to D.S.’s commentary), but they both end up at the same place: the enormous risks we are sowing with abnormal monetary policies. The economy is not nearly as healthy as the Fed would like, but pockets of the economy are bubbling up while other pockets are still deflating. There is a correlation relationship, probably causal.

The problem with “inflation targeting” is that bubble economics warps relative prices and so the correction must drive some prices down and others up. In other words, massive relative price corrections are called for. But inflation targeting targets the general price level as measured by biased sample statistics – so if the Fed is trying to prop up prices that previously bubbled up and need to decline, such as housing and stocks, they are pushing against a correction. The obvious problem has been these debt-driven asset prices, like stocks, government bonds, and real estate. In the meantime, we get no new investment that would increase labor demand.

The global economy needs to absorb the negative in order to spread the positive consequences of these easy central bank policies. The time is now because who knows what happens after the turmoil of the US POTUS election?

Ending the Fed’s Inflation Fixation

The focus is misplaced—and because it delays an overdue interest-rate rise, it is also dangerous.

By MARTIN FELDSTEIN
The Wall Street Journal, May 17, 2016 7:02 p.m. ET

The primary role of the Federal Reserve and other central banks should be to prevent high rates of inflation. The double-digit inflation rates of the late 1970s and early ’80s were a destructive and frightening experience that could have been avoided by better monetary policy in the previous decade. Fortunately, the Fed’s tighter monetary policy under Paul Volcker brought the inflation rate down and set the stage for a strong economic recovery during the Reagan years.

The Federal Reserve has two congressionally mandated policy goals: “full employment” and “price stability.” The current unemployment rate of 5% means that the economy is essentially at full employment, very close to the 4.8% unemployment rate that the members of the Fed’s Open Market Committee say is the lowest sustainable rate of unemployment.

For price stability, the Fed since 2012 has interpreted its mandate as a long-term inflation rate of 2%. Although it has achieved full employment, the Fed continues to maintain excessively low interest rates in order to move toward its inflation target. This has created substantial risks that could lead to another financial crisis and economic downturn.

The Fed did raise the federal-funds rate by 0.25 percentage points in December, but interest rates remain excessively low and are still driving investors and lenders to take unsound risks to reach for yield, leading to a serious mispricing of assets. The S&P 500 price-earnings ratio is more than 50% above its historic average. Commercial real estate is priced as if low bond yields will last forever. Banks and other lenders are lending to lower quality borrowers and making loans with fewer conditions.

When interest rates return to normal there will be substantial losses to investors, lenders and borrowers. The adverse impact on the overall economy could be very serious.
A fundamental problem with an explicit inflation target is the difficulty of knowing if it has been hit. The index of consumer prices that the Fed targets should in principle measure how much more it costs to buy goods and services that create the same value for consumers as the goods and services that they bought the year before. Estimating that cost would be an easy task for the national income statisticians if consumers bought the same things year after year. But the things that we buy are continually evolving, with improvements in quality and with the introduction of new goods and services. These changes imply that our dollars buy goods and services with greater value year after year.

Adjusting the price index for these changes is an impossibly difficult task. The methods used by the Bureau of Labor Statistics fail to capture the extent of quality improvements and don’t even try to capture the value created by new goods and services.

The true value of the national income is therefore rising faster than the official estimates of real gross domestic product and real incomes imply. For the same reason, the official measure of inflation overstates the increase in the true cost of the goods and services that consumers buy. If the official measure of inflation were 1%, the true cost of buying goods and services that create the same value to consumers may have actually declined. The true rate of inflation could be minus 1% or minus 3% or minus 5%. There is simply no way to know.

With a margin of error that large, it makes no sense to focus monetary policy on trying to hit a precise inflation target. The problem that consumers care about and that should be the subject of Fed policy is avoiding a return to the rapidly rising inflation that took measured inflation from less than 2% in 1965 to 5% in 1970 and to more than 12% in 1980.

Although we cannot know the true rate of inflation at any time, we can see if the measured inflation rate starts rising rapidly. If that happens, it would be a sign that true inflation is also rising because of excess demand in product and labor markets. That would be an indication that the Fed should be tightening monetary policy.

The situation today in which the official inflation rate is close to zero implies that the true inflation rate is now less than zero. Fortunately this doesn’t create the kind of deflation problem that would occur if households’ money incomes were falling. If that occurred, households would cut back on spending, leading to declines in overall demand and a possible downward spiral in prices and economic activity.

Not only are nominal wages and incomes not falling in the U.S. now, they are rising at about 2% a year. The negative true inflation rate means that true real incomes are rising more rapidly than the official statistics imply. [Sounds good, huh? Not quite. Read Stockman’s analysis.]

The Federal Reserve should now eliminate the explicit inflation target policy that it adopted less than five years ago. The Fed should instead emphasize its commitment to avoiding both high inflation and declining nominal wages. That would permit it to raise interest rates more rapidly today and to pursue a sounder monetary policy in the years ahead.

inflation-vs-employment

Share the Wealth?

The Third Way? No, the Only Way forward. It’s called peoples’ capitalism, the Ownership Society, employee ownership, inclusive capitalism, etc. (Ironic how Reich has embraced a concept introduced in national politics by George W. Bush.)
Reprinted from the Huff Post. Comment below…

The Third Way: Share-the-Gains Capitalism

by Robert Reich

Marissa Mayer tells us a lot about why Americans are so angry, and why anti-establishment fury has become the biggest single force in American politics today.

Mayer is CEO of Yahoo. Yahoo’s stock lost about a third of its value last year, as the company went from making $7.5 billion in 2014 to losing $4.4 billion in 2015. Yet Mayer raked in $36 million in compensation.

Even if Yahoo’s board fires her, her contract stipulates she gets $54.9 million in severance. The severance package was disclosed in a regulatory filing last Friday with the Securities and Exchange Commission.

In other words, Mayer can’t lose.

It’s another example of no-lose socialism for the rich — winning big regardless of what you do.

Why do Yahoo’s shareholders put up with it? Mostly because they don’t know about it.

Most of their shares are held by big pension funds, mutual funds, and insurance funds whose managers don’t want to rock the boat because they skim the cream regardless of what happens to Yahoo.

In other words, more no-lose socialism for the rich.

I don’t want to pick on Ms. Mayer or the managers of the funds that invest in Yahoo. They’re typical of the no-lose system in which America’s corporate and financial elite now operate.

But the rest of America works in a different system.

Theirs is cutthroat hyper-capitalism — in which wages are shrinking, median household income continues to drop, workers are fired without warning, two-thirds are living paycheck to paycheck, and employees are being classified as “independent contractors” without any labor protections at all.

Why is there no-lose socialism for the rich and cutthroat hyper-capitalism for everyone else?

Because the rules of the game — including labor laws, pension laws, corporate laws, and tax laws — have been crafted by those at the top, and the lawyers and lobbyists who work for them.

Does that mean we have to await Bernie Sanders’s “political revolution” (or, perish the thought, Donald Trump’s authoritarian populism) before any of this is likely to change?

Before we go to the barricades, you should know about another CEO named Hamdi Ulukaya, who’s developing a third model — neither no-lose socialism for the rich nor hyper-capitalism for everyone else.

Ulukaya is the Turkish-born founder and CEO of Chobani, the upstart Greek yogurt maker recently valued at as much as $5 billion.

Last Tuesday Ulukaya announced he’s giving all his 2,000 full-time workers shares of stock worth up to 10 percent of the privately held company’s value when it’s sold or goes public, based on each employee’s tenure and role at the company.

If the company ends up being valued at $3 billion, for example, the average employee payout could be $150,000. Some long-tenured employees will get more than $1 million.

Ulukaya’s announcement raised eyebrows all over corporate America. Many are viewing it as an act of charity (Forbes Magazine calls it one of “the most selfless corporate acts of the year”).

In reality, Mr. Ulukaya’s decision is just good business. Employees who are partners become even more dedicated to increasing a company’s value.

Which is why research shows that employee-owned companies — even those with workers holding only a minority stake — tend to out-perform the competition.

Mr. Ulukaya just increased the odds that Chobani will be valued at more than $5 billion when it’s sold or its shares of stock are available to the public. Which will make him, as well as his employees, far wealthier.

As Ulukaya wrote to his workers, the award isn’t a gift but “a mutual promise to work together with a shared purpose and responsibility.”

A handful of other companies are inching their way in a similar direction.

Apple decided last October it would award shares not just to executives or engineers but to hourly paid workers as well. Twitter CEO Jack Dorsey is giving a third of his Twitter stock (about 1 percent of the company) “to our employee equity pool to reinvest directly in our people.“

Employee stock ownership plans, which have been around for years, are lately seeing a bit of a comeback.

But the vast majority of American companies are still locked in the old hyper-capitalist model that views workers as costs to be cut rather than as partners to share in success.

That’s largely because Wall Street still looks unfavorably on such collaboration (remember, Chobani is still privately held).

The Street remains obsessed with short-term stock performance, and its analysts don’t believe hourly workers have much to contribute to the bottom line.

But they’re prepared to lavish unprecedented rewards on CEOs who don’t deserve squat.

Let them compare Yahoo with Chobani in a few years, and see which model works best.

If I were a betting man, I’d put my money on Greek yoghurt.

And I’d bet on a model of capitalism that’s neither no-lose socialism for the rich nor cruel hyper-capitalism for the rest, but share-the-gains capitalism for everyone.

 ——————
My comment:
Reich’s argument for inclusive “ownership” capital is certainly a welcome improvement over artificially raising labor costs through wage mandates or union restrictions. Kudos to Mr. Ulukaya, but a more widely adopted model can’t rely solely on enlightened capitalists. Mr. Reich glosses over the important issue of who bears the risks of capitalist enterprise before success. Sharing the gains unfortunately also means sharing the financial risks, or the direct relationship between human loss aversion and risk-taking enterprise collapses. In other words, nobody gets to receive gains without taking risks and nobody take risks without expected gains. If that truth escapes you, you’re probably not a casino gambler.
Mr. Ulukaya bore these risks and now wisely seeks to share the risks and rewards going forward. But these ownership rights should be negotiated by employees across the economy and can’t rely on the benevolence of successful entrepreneurs. Labor organizations could play a collective action role here on securing and enforcing ownership rights. The public sector also should address how economic risks can be better managed through a functioning private insurance market complemented by social insurance where private markets are incomplete.
The current desire to centralize risk and control in big government, big business, and big labor is sorely misguided and it would be helpful if both left and right could come together on that fact. Ideology be damned.
———-
I include this cartoon below for its comic irony. So many people reading this article mistake Reich’s argument for Bernie Sanders-style socialism when it is the exact opposite. It’s about extending capital ownership to labor, whereas socialism is about abolishing capital ownership in favor of some altruistic notion of communalism.
share-the-candy

What Is Inclusive Capitalism?

We can distill “inclusive capitalism” down to a single word that captures the concept in its fullest dimensions. That word is EQUITY.

There is a movement afoot called The Coalition for Inclusive Capitalism that counts Prince Charles, Pope Francis, Bill Clinton, and the world’s richest industrialist Carlos Slim among its supporters. Our first reaction to this news might be to ask, “What exactly is meant by the term Inclusive Capitalism?”

The Coalition provides this definition:

“Inclusive Capitalism provides that firms should account for themselves, not just on the bottom line, but on environmental, social, and governance (ESG) metrics… Every firm has a license to operate from the society in which it trades. This is both a legally and socially defined license… Firms must contribute proportionately to the societies in which they operate. Without fairly contributing, firms free-ride on services that other people have paid for. Firms that practice unsustainable activities, disrespect their stakeholders and the communities in which they operate will find their licenses threatened, first by the engaged consumer, then by government. Firms practicing Inclusive Capitalism will see their license strengthened.”

While laudable in its aspirations, operationalizing this value-laden definition poses a few questions and challenges.

First, this definition focuses on firm responsibility according to ESG sustainability metrics and firm performance. In fact, citing studies of corporate performance measures, the IC literature asserts that such practices deliver superior firm performance in terms of profit and market valuations. If true, then market competition should insure the widespread adoption of best practices with the gradual attrition of less profitable, less sustainable firm behavior. In other words, markets should provide sufficient correctives. If they do not, we probably need to question such assumptions that the market is functioning as expected, that it is complete, or that best practices across firms and industries are readily transparent.

Second, one can inadvertently blur the operational differences between public corporations and non-corporate, small business where ESG metrics are more difficult to discern or measure. Since much of capitalism’s innovation, job creation, and business expansion occurs at the small business level, we need to expand the idea of inclusion beyond corporate management practices and stakeholder governance.

Third, the search for an acceptable definition can also put different class segments of society at odds. The British Guardian has already described the Coalition’s efforts as a “Trojan Horse” cynically deployed to placate the public so that crony capitalism can thrive unscathed. Our definition then must not only articulate a vision and a direction, but also gain acceptance and buy-in from all segments of society. In other words, our definition must be “inclusive” in order to mediate conflicts among groups that appear to harbor diverging interests.

Finally, when we probe practitioners we find that different people have different ideas of what Inclusive Capitalism means, so we still lack a consistent and concise definition. Perhaps we can start by eliminating what it is not. It’s more than just corporate social responsibility (CSR) or ESG sustainability. It’s not defined by charity, philanthropy, or noblesse oblige. It’s more than “people-centered” and not really Robin Hood-style tax and redistribution, or even social welfare.

This is not to declaim or disparage these policies and activities, which in many cases yield positive social and economic results. The problem is that these policies are not really designed to be inclusive; rather they target compensation for past exclusion. In contrast, we should understand that inclusive capitalism seeks to reduce the need for such compensation. Thus, the motivating criterion is bottom-up empowerment, not top-down redirection. For example, inclusive capitalism is less about artificially raising wages, and more about creating the demand for and utilization of labor where a minimum or living wage becomes a moot issue.

With this objective, I believe we can distill “inclusive capitalism” down to a single word that captures the concept in its fullest dimensions. That word is EQUITY. Why equity? Because the multiple meanings and usage of the word “equity” expand the idea into every realm of a free society: political equity in terms of democratic participation, legal equity in terms of rights and accountability, moral equity in terms of justice, and economic equity in terms of capital ownership structures, control, risk, and reward. A free society that lacks any one of these dimensions of equity is in need of repair.

Economic Equity

Naturally, the focus of the term “inclusive capitalism” applies primarily to economic equity, begging the next question of how we define and understand economic equity. This can be problematic because a moral precept of equity as “fairness” is not definitive. In other words, What is economically fair? is a question that cannot really be answered objectively. In economic relations, equity implies a linkage between action and consequence; in finance we might refer to the direct link between risk and reward. In fact, the financial framework may offer the clearest insight into the logic of economic equity in capitalism.

Economic growth is a result of successful risk-taking and productive work. The rewards of success are, or should be, distributed accordingly. The simplest formulation asserts that capital takes the risks and labor does the work. The distributional outcomes of success or failure are then perceived as a protracted conflict between capital and labor over issues of equity. I would argue this conflict is misconstrued.

The linkage between risk and reward is inter-temporal. In other words, financial risks are assigned and taken before the enterprise is engaged: capital is borrowed and invested, suppliers are paid, and labor is contracted. The payment contracts reflect a complex web of legal relations and covenants that stipulate the assignment of liabilities and the seniority of claims over the product after it has been produced and, hopefully, sold. The liability risks of all participants are encoded in these contracts. After standard accounting practices measure the results, the returns to success or the losses of failure are distributed accordingly.

In starkest terms: In capitalism, she who takes the risk, gets the reward (or the loss). We can see the importance of residual claimancy over the profits of the enterprise. Under most corporate legal covenants, these profits accrue to “equity holders,” also referred to as shareholders or owners of firm assets. We should note the usage of that word “equity.”

Inclusive capitalism warrants “inclusion” in the profit-making enterprise of capitalism, which by legal necessity requires contractual claims on residual profits as well as the assumption of liabilities for loss. To control the financial risks associated with these liabilities, the corporate charter was deliberately designed to limit liability to the liquidation value of the firm’s assets.

Some correctly make the argument that wider stakeholders in capitalism (those without ownership claims) have rights that should be reflected in the governance of capitalist enterprise. An example might be a community downriver that suffers water contamination from a producer upstream. Economic externalities, such as environmental degradation, are important considerations for inclusion. Politically imposed regulation can be one means of asserting stakeholders’ interests, but the preferred strategy would be to assign stakeholder claims through the accepted legal structures of ownership and control. In other words, stakeholders should be represented as the voice of shareholders participating as owners in capitalist enterprise. In this way, stakeholders assert their interests and can also claim the material benefits of success, i.e., profits.

Thus, inclusive capitalism explicitly requires inclusion in the economic system as “capitalists,” as well as workers. This all can be as simple as being a passive shareholder. This begs the penultimate question of why, in a capitalist economy, we are not all striving to be capitalists? Alternatively, we might ask: Why is economic inclusion so elusive?

I believe this is where the discussion of inclusive capitalism gets interesting. The answers hinge on the risk-taking nature of capitalist enterprise juxtaposed against the risk-averse, loss-averse behavior dictated by our natural survival instinct. There is a selective bias among successful capitalists to perceive a natural order of things whereby some people are natural risk-taking innovators, while others are not. For them, this “natural order” explains the distribution of success in a capitalist society. The elitist bias can reveal itself in attitudes of paternalism and noblesse oblige.

This perspective is largely the product of a theoretical approach to the market economy where participants are grouped by function: producers vs. consumers; employers vs. workers; investors and borrowers vs. savers and lenders; innovators and wealth-creators vs. welfare dependents. When it comes to distributional outcomes, this is a limited analytical paradigm. Let us just consider the risk-takers. Innovators like Bill Gates, Steve Jobs, Jeff Bezos, or Google’s Page and Brin are perhaps one in a million. But each of these immensely successful individuals has been eager to share the risks and returns of their enterprise through the sale of equity in financial markets. The important lesson is not the fact that Gates may have a net worth of more than $30 billion, but that Microsoft (and Apple and Amazon) has enriched thousands of other stakeholders along the way. This is the key to inclusion and we should pay mind to how it is narrowing.

Though risk preferences and animal spirits do vary across the population, economic risk is ubiquitous and borne in some manner by all. As the capitalist risks loss of principal, the worker risks loss of income. The real question is whether the risk-bearers are receiving just compensation commensurate with those risks and whether the risk-takers are also accountable for losses. This is equity in the moral and economic sense of the word. A free society demands that the innocent not pay for the mistakes of the guilty and this applies in capitalist enterprise as well. (Our recent financial bail-outs appear to have violated this moral imperative.)

For inclusion to work, participants in capitalist enterprise must also be empowered to control and manage their risks. Inclusion and participation then becomes a question of enforceable property rights and gets us back to the legal conventions of assigning ownership rights and risks to tangible assets of the firm. In many situations, different stakeholders eschew the risks because they cannot control or manage them, so they pay to have someone else assume them (i.e., sign a labor contract for a lower risk-return profile). Overcoming these impediments to equity participation inherent to the governance issue is the main challenge of inclusion.

Unfortunately, we have many tax and regulatory policies, as well as financial practices and conventions, that contradict the goal of inclusion through equity. Access to credit, debt leverage, collateral requirements, capital and income taxes, conflicts of interest in governance, etc. work to the disadvantage of those who are thereby excluded from the financialization of the economy. A long laundry list of reforms can be offered in this respect, but that is beyond the purview of this effort, which is to first define what we mean by inclusive capitalism.

A more serious challenge is posed by an industrial global economy being transformed by the digital information age, globalization, and AI robotics. Production in the digital age is revealing itself as labor-saving, capital and skill intensive, with winner-take-all product and service markets. Some of the effects we observe are the rise of celebrity branding; the marginalization of wage labor as a distributional mechanism and mode of inclusion; and the explosive growth of wealth concentration enjoyed by those who feed off digital processes—companies like Amazon, Apple, Google, and Facebook. These trends present a dire challenge to the concept of equity and inclusion. It is a challenge that will require far deeper thinking and rethinking of the 21st century economy and how we conceive of a free society. Despite what politicians may promise, I would advise there is no going back.

House of Cards: Truth Stranger Than Fiction

As a political economist and policy analyst I have to say I’ve found the NetFlix series, House of Cards very entertaining. Of course, it is over the top with political sleaze and corruption, something that probably syncs well with the public’s impression of Washington politics these days. (I find it interesting that the writers chose to designate the depraved, murderous POTUS Frank Underwood, played by Kevin Spacey, as a big “D” Democrat. With an annoyingly ambitious, self-righteous wife as co-president – sound familiar? Apparently, depravity with good intentions is somewhat acceptable these days in partisan circles, with Underwood often turning to the audience to explain the bare facts of Machiavellian realpolitik. How unfortunate for poor Niccolo, who was a true republican patriot, but recast by history as the apologist for a ruthless, depraved Prince.)

I have been most amused by Season 3, where Pres. Underwood proposes a massive jobs program paid for by slashing entitlements. This is just too juicy to let pass unnoticed. Let’s translate this “promise” of a full employment Nirvana: “I’m going to take your hard earned money we extorted through Social Security and Medicare taxes and give it away to companies that will employ workers for jobs that the productive private economy will not create because they lose money. Isn’t that grand? We’ll all feel better about humanity, even though we’ll be poorer for it (all except me, that is).”

The irony is that this absurd fiction is actually proposed too often as serious politics in the real Washington D.C. Quite a few other bloggers have explained the surrealness of a POTUS creating jobs from whole cloth just because he can command it from the White House. The numbers just don’t add up. But I was struck more by the widely accepted premise that asserts “jobs” as the end-all of what ails a society of free citizens. The Underwood character actually says, “People are dying from unemployment!” This cuts pretty close to home with Obama recently claiming that “chanting ‘Death to America’ does not create jobs.” Really? Is that what they’re beheading innocents over, a few good jobs?

People don’t die from unemployment, they die from poverty, deprivation, and disease. They die from oppression and violence. Unproductive jobs subsidized by governments do not alleviate poverty, they merely spread poverty around. The thing is, politicians focus on jobs because that is the only way they know how to spread the benefits of capitalism around the population. But we are moving into a new age that departs from the skilled labor-intensive manufacturing of the post-WWII years. Our financial policies have accelerated this trend away from labor by providing cheap capital to take advantage of cheaper labor overseas or machine/robot substitution. We are entering the information, artificial intelligence, and robotics age, and yet our politicians are still making false promises of a job and two chickens in every pot. Not going to happen. We need to think outside that box to discover how we are going to create and share wealth in the new economy. There are many alternative ways to participate in a market economy than solely as a labor input.

In the meantime, enjoy the entertainment. It’s hilarious. But don’t expect a job from America Works.

Beyond Piketty’s Capital

Income-USA-1910-2010

What Ben Franklin and Billie Holiday Could Tell Us About Capitalism’s Inequalities

It has now been two years since French economist Thomas Piketty published his tome, Capital in the Twenty-First Century, and one year since it was published in English, raising a fanfare of praise and criticism. It has deserved both, most notably for “putting the distributional question back at the heart of economic analysis.”[1] I would imagine Professor Piketty is also pleased by the attention his work has garnered: What economist doesn’t secretly desire to be labeled a “rock-star” without having to sing or pick up a guitar to demonstrate otherwise?

Piketty’s study (a collaborative effort, to be sure) is an important and timely contribution to economic research. His datasets across time and space on wealth, income, and inheritances provide a wealth of empirical evidence for future testing and analysis. The presentation is long, as it is all-encompassing, tackling an ambitious, if not impossible, task. But for empirics alone, the work is commendable.

Many critics have focused on methodology and the occasional data error, but I will dispense with that by accepting the general contour of history Piketty presents as accurate of real trends in economic inequality over time. And that it matters. Inequality is not only a social and political problem, it is an economic challenge because extreme disparities break down the basis of free exchange, leading to excess investment lacking productive opportunities.[2] (Piketty ignores the natural equilibrium correctives of business/trade cycles, presumably because he perceives them as interim reversals on an inevitable long term trend.) I have followed Edward Wolff’s research long enough to know there is an intimate causal relationship between capitalist markets and material outcomes. I believe the meatier controversy is found in Piketty’s interpretations of the data and his inductive theorizing because that tells us what we can and should do, if anything, about it. Sufficient time has passed for us to digest the criticisms and perhaps offer new insights.

Read the full essay, formatted and downloadable as a pdf…

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[1] Distributional issues are really at the heart of our most intractable policy challenges. Not only are wealth and income inequalities distributional puzzles, so are hunger, poverty, pollution, the effects of climate change, etc. Unfortunately, the profession tends to ignore distributional puzzles because the necessary assumptions of high-order mathematical models that drive theory rule out dynamic network interactions that characterize markets. Due to these limitations, economics is left with the default explanations of initial conditions, hence the focus on natural inequality, access to education, inheritance, etc. General equilibrium theory (GE) also assumes distributional effects away: over time prices and quantities will adjust to correct any maldistributions caused by misallocated resources. For someone mired in poverty or hunger, it’s not a very inspiring assumption.

[2] As opposed to distributional problems, modern economics is very comfortable studying and prescribing economic growth. Its mathematical models provide powerful tools to study and explain the determinants of growth. This is why growth is often touted as the solution to every economic problem. (When you’re a hammer, everything looks like a nail.) But sustainable growth relies on the feedback cycle within a dynamic market network model, so stable growth is highly dependent on sustainable distributional networks.

Rethinking Inequality and Redistribution in a Free Society

taxtherich

Inequality has become a hot political topic these days and may be most contentious issue of the 2016 presidential election (unless a geopolitical crisis occurs before then). The study of economic inequality and what to do about it has a long history though, and not much has changed.

In this post I would like to suggest some different ways of looking at the problem and what to do about it from a policy perspective. Many people look at the distributional outcomes of success in a winner-take-all society and declaim the results as unfair. It probably is unfair, just like it is when all the tallest kids get chosen to play on the basketball team. But, more seriously, fairness is not an objective measure by which we can set policy.

Most people think they can define what’s fair and what’s not. I would tend to agree, but mine probably departs from the common sense definition. When looking at results in life, one person’s fairness (the winners’ bracket) is another’s unfairness (the losers’ bracket). So, should fairness be determined by who has the most political power and influence in society, even if that is a tyranny of the majority? I fail to see how that would be fair.

Fairness can actually be defined by the legal idea that consequence should follow action. In other words, the guilty, not the innocent, should pay for their sins. In finance, this idea of fairness is couched in the concept of risk and reward: he who takes the risk, reaps the reward (or the loss).

The question is how do we apply this objective idea of fairness (I would prefer the word “justice”) to policies to mitigate unequal outcomes? Or even should we?

I will argue that we should, but that we’re devising all the wrong policies because we are trapped in a conceptual maze. Economic inequality is truly a maze of confusion. There are many different factors that lead to unequal results and it’s quite easy and common to focus on the wrong ones. The factors that have become politically salient today are related to the diverging returns between capital and labor. This is at the root of all the hullabaloo over French economist Thomas Piketty’s work, a work that has been politicized to confirm the worse fears of labor advocates.

In short, globalization and technology has led to wage repression for the 99%, while increasing the returns to capital (the 1%). The keen-jerk solution is to tax capital after the fact and redistribute the funds to labor. The POTUS stated this proposal explicitly in his recent SOTU address: “Let’s close the loopholes that lead to inequality by allowing the top 1 percent to avoid paying taxes on their accumulated wealth.” In effect, he was advocating for tax reform, but he failed to specify details. But we have a good idea on what kind of economic policies Mr. Obama favors: free community college tuition, minimum wage laws, family childcare and education credits, paid sick leave. One can argue the pros and cons of these policies, but none of them really addresses the growing problem of inequality. My guess is that is because the administration really doesn’t have any new ideas about what to do about inequality except to wave it as a red flag during election season.

There is a serious problem with trying to tax capital to redistribute to labor that I would like to present here in the simplest of terms. Capital has dominant strategies to win any conflict with labor in a free society. If we tax capital, it can instantly move elsewhere to avoid the tax. Financial capital is fungible, it can change it’s use. Or it can lie dormant in the bank vault or a mattress. Labor enjoys none of these advantages: we can’t easily get up and move, we are specialized by skills and education, and we can’t be idle for long because we have to eat. In a class war between capital and labor, labor must capitulate, at least in a free society.

The political measures that seek to prevent this – such as repatriation laws, tax penalties, capital controls, crackdowns on tax havens and accounting rules – are largely ineffective because capital enjoys these freedoms that are partly incumbent to its nature. Eliminating capital mobility would require the complete coordination of the international community, which implies state control over the deployment of capital. This would be contradictory to a free society, as much as the complete state control of labor mobility would. In other words, state coercion is incompatible with a free society and thus any tax costs will fall mostly on labor. This is not the result we want.

So, are we stuck in an impossible situation where those who own and control capital dominate those who don’t? I don’t believe so, but the solutions lie outside the present constellation of policies.

The first lesson is that if capital dominates the distribution of returns, then success in capitalism requires access, ownership, and control of capital.  Simply put, in a capitalist society, why aren’t we all clamoring to become capitalists? (You don’t have to run a business to be a capitalist, you just need to buy into public corporate share ownership and control.)

The next objection is that capital ownership and control cannot be pried from the hands of the rich and powerful without coercion by a democratically-elected government. In other words, we’re back to tax coercion. It is certainly true that we can tax physical capital and wealth through property and estate taxes. A mansion cannot be moved or disappear because it is taxed and the tax cannot be avoided by selling the property since the sales price will instantly reflect the tax liability. Wealth taxes are probably necessary due to the massive transfer of wealth under the misguided policies of the past two decades, but we’re missing the larger point if we focus solely on this redistribution of wealth after the fact. (My proposal for estate taxes is that they could be avoided entirely if the estate distributed the capital in limited amounts voluntarily according to the wishes of the principal. This happens to a certain extent with charitable gifts, but I would broaden the idea to cover any beneficiaries.)

However, beyond wealth taxes, there IS a way to incentivize someone to surrender at least some of their capital voluntarily. In fact, we all do it all the time when we buy insurance. By paying insurance premiums we surrender capital wealth in order to reduce risk and preserve the remainder. The rich have long practiced capital preservation strategies to protect their wealth. So risk is exchanged with capital.

This is also how Wall Street bankers get rich – they assume risk, manage it successfully, and then reap the rewards. So, if those without capital assume the equity risks going forward, and their property rights are vigorously defended, they can reap the rewards of economic success through their labor and their capital accumulation. The rich willingly give up some of their control in return for reducing their risks. As a society we can redistribute wealth by redistributing and managing risk.

This happens now when we save and invest in new business ventures, or accumulate a portfolio of financial assets such as stocks and bonds. But to really make a dent in inequality we must broaden and deepen capital ownership with a range of policy reforms that consistently reward working, saving, investing, accumulating capital, and diversifying risk. In a free society the government was never meant to do all of this for us, especially when we can do it better ourselves. I also would not expect most politicians in Washington to someday wake up and discover these reforms by themselves.

 

 

 

 

Why Ownership Matters

TheOwnershipSociety

A little over a decade ago, in 2004 to be exact, the subject of ownership in democratic capitalist society was raised as a national political issue. Attribution goes to President George W. Bush, as he was campaigning for a second term, when he stated, “…if you own something, you have a vital stake in the future of our country. The more ownership there is in America, the more vitality there is in America, and the more people have a vital stake in the future of this country.” He called his vision The Ownership Society and it became the theme of his campaign. Naturally, his political opponents pounced on the idea, deriding it as the You’re-On-Your-Own Society, with the catchy acronym of “YO-YO.”

At the time I found the original statement to be more profound than was probably intended by its conservative proponents. My doubts were confirmed when the focus soon narrowed to the Holy Grail of residential home ownership, which was experiencing a boom due to policies favored by both parties that powered a historic bubble based on cheap credit and lowered lending standards. In the final capitulation to politics, the ownership agenda was reduced to, and attacked as, a naked partisan strategy to privatize entitlements, primarily to carve away support for liberal Democratic proponents of the social welfare state.

However, I don’t see ownership as a partisan issue, or even an ideological one, despite the fact that our political class certainly does. Instead, I see it as a theoretical and empirical issue that goes far beyond policy or politics to encompass economics, psychology, moral philosophy, and evolution.

For reasons that will become apparent, I will define this discussion to the ownership of financial capital. The ownership and control of capital assets is essential in the age of capital for two main reasons: first, it enables people to diversify against the risks of change; and two, the establishment of ownership rights is how the market and our legal system determine the distribution of returns to those aforementioned risks. Thus, ownership rights serve to determine the distribution of both a priori risks of, and a posteriori returns to, uncertain change.

Managing Risk

The best way to illustrate these two assertions is with the analogy of a roulette game. Imagine that several players with equal stakes gather around the roulette table. They wager their ownership stakes according to different risk preferences, some playing single numbers (highly risky) down to those who play black or red, odd or even (less risky). After each turn of the wheel the winners receive pay-offs or absorb losses in proportion to the odds ratios, or risks, of their strategies. In other words, if one played a single number or a row of numbers that hit while another played a red or black, the first would receive a much larger pay-off because she would have taken a much higher risk of loss. What we see if we examine the odds ratios of all the different plays on the roulette table is that the risk-adjusted rates of return of all strategies are essentially equal (and favor the casino ever so slightly). If the return/risk ratios are all the same, the only way to increase one’s return is to increase one’s risks and manage them successfully. This risk-return trade-off is the foundation of finance theory.

Behavioral studies show that we are uniformly loss averse. Since we cannot know the future, uncertainty and the risk of loss is inherent to our existence (although every tomorrow also offers hope for new opportunities). The best way to insure against losses due to unpredictable risks is through diversified pooling. We do this when we buy auto or homeowners insurance. These insurance pools are in fact diversified portfolios of capital assets. Likewise, ‘saving for a rainy day’ is a form of self-insurance. Due to the asymmetric information of insurance, certain problems arise that we call moral hazard and adverse selection. Moral hazard is when the beneficiary of the insurance changes risk-taking behavior because they are insured. This is like someone who drives recklessly because they have insurance to cover the cost of an accident. However, if the insurance issuer knew the person was going to change their risk behavior it would demand higher premiums. Adverse selection is when good risks opt out of an insurance pool with bad risks, causing the risk pool to become more risky and require ever higher premiums until the pool breaks down. Because we know our own risk-taking behavior better than anyone else, both of these insurance problems result from asymmetric information.

We can see that self-insurance doesn’t not suffer from asymmetric information because we are essentially insuring ourselves, so the incentive to drive recklessly is irrational. For this reason, self-insurance incurs no agency costs and is by far more efficient than insurance pooling. But to self-insure, i.e. save for a rainy day, we must accumulate assets to diversify in a portfolio. Thus, asset ownership is essential.

A second analogy—the scientific principle of natural selection and species adaptation—reinforces the importance of risk diversification. Nature constantly adapts to unpredictable change and the imperatives for survival by promoting diversification. Biodiversity is nature’s way of achieving a sustainable ecological balance and we can imagine human societies are certainly subject to the same survival imperatives.

Sharing the Rewards

If we not only want to protect ourselves from unpredictable risks of loss but also want to share in the returns to capitalist success, we must accumulate capital assets through ownership, put them at risk, and manage those risks successfully. Establishing the policies and complementary institutions, both private and public, to facilitate this process is actually the primary policy challenge of a free democratic society. In this sense, George Bush and his critics were both right: One must take an ownership stake in America to reap her benefits, and in so doing, one assumes the risk of loss and the obligation to manage that risk successfully.

Critics of this view might ask why capitalist profits are not more justly distributed through the payment of input costs, such as labor. The problem is exactly that: labor is an input cost that must be minimized under the profit incentive in order for the enterprise to succeed in a competitive environment. With access to a world supply of labor, the dynamics of capitalism exert constant downward pressure on wages. Laborists have long sought to use countervailing political power to constrain capital, but this strategy conflicts with the globalization of free trade among sovereign nations. In an open global economy with mobile capital and immobile labor, capital has strategic dominance over labor in simple game theoretic terms. Capital can move instantaneously, withdraw, or lie dormant indefinitely.

Labor’s argument is also undermined by the fact that if workers take no explicit residual risk in the enterprise, they have no defensible ownership claim to a share in the residual profits of success. Fixed labor contracts, in effect, assign risk and thus profits to owners in return for lower, and, hopefully, more secure and stable compensation. But under fixed labor contracts, firm losses are largely, and unjustly, borne by the unemployed, who are not fairly compensated for these hidden risks in good times.

For these reasons, I believe it is a misguided political strategy to pit labor against capital in an adversarial relationship. The solution is for labor to participate in capitalist enterprise as owners as well as workers. Risk then is more broadly shared across all stakeholders rather than borne by the weakest members of the labor force.

Equally important is the policy demand to share the returns of capitalism more broadly. There has been growing public criticism of market capitalism due to cronyism and widening economic inequality. A quick analysis of the distribution of wealth and income will confirm that much of this inequality can be attributed to the benefits accruing to those who own and control financial capital. Corporate elites get rich off stock options as part of their compensation packages. Employees of successful tech start-ups become fabulously wealthy due to their equity participation, not salaries. More important, financial markets concentrate the rewards to success, especially through the use of debt leverage. Federal Reserve financial repression that keeps interest rates near zero has rewarded borrowers and asset holders while penalizing savers and workers. Enhancing labor skills through education can only mitigate these trends to a point. In capitalism today, it is essential to own and control financial capital.

Financing Adaptation and Innovation

The analogy to nature’s biodiversity suggested above is more consequential than may appear. Diversification helps species survive, but it does this by enhancing the ability to adapt successfully. Natural adaptation is synonymous with human discovery and innovation. There is a branch of social psychology that focuses on the science of human creativity and innovation and draws from the lessons of natural adaptation. In a seminal article in 1960, the psychologist Donald Campbell argued that creative thought depends on a two-fold procedure he called blind variation and selective retention (BVSR). Blind variation refers to undirected change, much like unpredictable mutation in genetics. Selective retention refers to the replication of successful change. His argument suggests that creative innovation frequently relies on novelty and surprise, as well as utility.

What does this mean in the context of technological innovation and discovery? It means that many creative discoveries in the sciences and the humanities result from unintended consequences and not deliberate, intentional efforts. In other words, discoveries often come out of the blue; creativity is magical in that it cannot be so much cajoled by deliberate effort as just being allowed to happen under the right conditions. A creative artist knows this well from experience. This research has implications for how we can stimulate economic innovation by sowing the seeds of risk-taking capital far and wide in order to reap the benefits of creativity and discovery. It also suggests the limits of directed risk-taking through the public sector or through the bottlenecks of private venture capital. The next new big thing (or just very successful small thing) is more likely to come out of a garage or kitchen and not be financed by either the state or the financial sector. More likely it will be financed by personal relationships referred to as angel financing. Broadening the accumulation and ownership of financial capital helps to broaden the reach of angel investment to fund unorthodox risk-taking.

Agency

There is an ubiquitous weakness inherent to economic systems of specialization and exchange, alluded to above in the insurance case, that is referred to as the “agency problem.” When a principal hires an agent, such as a sales agent or a manager, there is always a potential conflict of interest between the principal and the agent, which can end up being quite costly to the principal. This agency problem was recognized by Adam Smith and more recently by those who study industrial organization and the public corporation. Managers often have material interests that diverge from the principal owners, i.e., shareholders and other stakeholders of the corporation.

This agency problem can never be perfectly eliminated (except through small sole proprietorships), but economic efficiency demands that the costs be minimized by aligning the interests of all stakeholders. This has been at the root of the use of stock options and profit participation in compensation. It’s called having “skin in the game, ” but too frequently the game is played with somebody else’s skin. The abuse of stock options merely points out the pitfalls of misunderstanding the nature of ownership and control. Equity financed with other peoples’ money is not a good way to eliminate conflicts of interest and minimize risk behavior. A recent article in The Economist points to the relative success of family-owned private firms that minimize agency costs. But for the large corporation to grow through needed access to outside capital, minimizing agency costs requires transparency and close monitoring of owners’ interests. This will require the checks and balances of competing agents, such as an independent board that represents various stakeholders’ interests to management. I would suggest that this offers a positive role for organized labor—to represent their worker/shareholders so that their interests align with public shareholders in ownership and control.

Property Rights, Morality, and the Law

Because English common law was established to protect property, ownership is the linchpin of our contracts legal system: we assign losses or gains in transactions according to the legal ownership of tangible assets. We even have a maxim that says, “ownership is nine-tenths of the law.” The relevant principle is equity, in every meaningful legal, moral, and accounting sense of the word. The moral implication of the finance law of risk and reward should be apparent: those who bear the equity risk of the enterprise assume the losses of failure or reap the gains of success. The importance of equity claims can also be illustrated through accounting principles: on the income statement, input costs such as labor reduce profits that accrue to equity; on the balance sheet, labor contracts are a liability that reduce residual equity of the firm. A labor union that seeks excessive wage rents by controlling the supply of labor is actually using politics to exploit rents from the owners of capital. But if workers participate in equity, they merely shift claims from the cost to the profit side of the income statement and from the liability to the asset side of the balance sheet, all the while aligning their interests with the overall success of the enterprise. As implied, with their own “skin in the game,” they also share more of the risk.

Lastly, the legal statutes for business equity are consistent with the criminal code that states that the innocent shall not pay for the crimes of the guilty. In this light we can see that political cronyism that privatizes gains but shifts losses to taxpayers is not only an abrogation of ownership rights, it is a violation of the moral spirit of the law.

In summation, I have argued that capitalist ownership matters for the following reasons:
1. Accumulation of capital assets for self-insurance, minimizing risk through asset diversification, and reducing the need for after-tax entitlement transfers;
2. Sharing the benefits of capitalist success by broadening participation in the market economy. These benefits feed back into future consumption and investment demand while reducing the inequality generated by finance;
3. Broadening the sources of finance capital, helping to fund adaptation and innovation;
4. Reducing agency costs by aligning interests of stakeholders in capitalist risk-taking enterprise;
5. Reaffirming the moral and legal basis of equity and the law of risk and return through transparency and accountability.

These five reasons illustrate why ownership and control is an essential component of a free society. The ultimate challenge to an organic entity, whether a species or a civilization, is to adapt successfully to constant change. In economic terms, we need to harness the forces of change and adaptation for the long-run sustainability of the economy and security of society. There certainly are other social systems that attempt the same by eschewing private ownership and imposing top-down control, such as authoritarianism, national socialism or fascism, and communism. But none of these systems are able to assert the primacy of individual freedom and security that we hold inextricably entwined. To empower ownership is to advance freedom, to facilitate risk management under uncertainty, to spur adaptation and innovation, to affirm equity and justice, and ultimately, to foster peace and prosperity.

On the other hand, without ownership, we get feudalism:

feudalism-1percent

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